BVWire Issue #140-3 | May 20, 2014


Biggest trip-up during SEC exams of fund valuations

The Securities and Exchange Commission is in the midst of conducting “presence exams” of investment advisers to private funds that recently registered with the SEC. This is part of a two-year initiative—started in October 2012—designed to examine five areas the SEC sees as “high-risk.” Valuation is one of those high-risk areas (the others are marketing, portfolio management, conflicts of interest, and safety of client assets).

Watch out: During a presence exam, the SEC will interview the personnel responsible for implementing valuation policies and procedures, and that’s when the big trouble can start. “The number-one trip-up is when the different people involved are not all on the same page with respect to the valuation policies,” said Craig Ter Boss (Eisner Amper), speaking at the recent Current Topics in Business Valuation conference presented by the New York City chapter of the ASA. “If one person has a very different story than someone else, it’s likely that the SEC will issue a deficiency notice.” Therefore, everyone—at all levels—needs to be consistent when it comes to the fund’s valuation policies and procedures.

The SEC has conducted approximately 250 audits and is within reach of its goal of visiting 25% of the firms during the course of this initiative, according to Ter Boss. He also pointed out that the SEC has issued deficiency letters in about half of the exams it has conducted.

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How to put the ‘reasonable’ back into royalty calculations

Laments about the scarred patent landscape—the patent trolls, the forum shopping, the exorbitant reasonable royalty awards—are nothing new. But a recent paper is noteworthy for proposing steps to restore the “reasonable” in the royalty analysis.

Simple solution: According to the author, Dan McManus, an intellectual property lawyer, the problem is simple and so is the solution. Patents are difficult to value. As a result, the jury (or sometimes the judge) often splits the difference between the two opposing values as a compromise. If the litigating parties know that this is likely to happen, they have an incentive to argue for damages as far away from the opposing party’s position as possible. In this way, each party tries to skew the midpoint of the resulting split to its side as much as possible. This “misaligned incentive,” says McManus, produces unreasonable and unpredictable royalty awards. We need to create an incentive for the parties to argue in favor of the most reasonable amount. How?

For one, McManus advocates for making Daubert challenges mandatory in jury cases because they allow the trial court to preclude problematic royalty calculations—last week’s BVWire case illustrates this point. Also, experts must give examples of royalty rates for licensing of similar patents or any existing exemplar licenses of the same patent. This means stating the number of patents on the product that was the royalty base for that similar royalty rate. Having to do so, says McManus, normalizes the royalty rates because a 3% royalty rate on a product containing 10 patents is not really comparable to a 3% royalty rate on a product containing 100 patents. Also, make the jury pick either the plaintiff expert’s or the defendant expert’s royalty rate as a starting point for the calculation, not just pick the midpoint. The author likens this approach to “final-offer arbitration” or “baseball arbitration”—a way of resolving salary disputes in Major League Baseball. All of these steps help to narrow the difference between the parties’ royalties and bring the process closer to how and what the parties might negotiate before the infringement. Willing licensors and licensees make reasonable arguments because they do not want to risk losing a potentially valuable royalty or license, McManus says.

Tiered system: Finally, he proposes a tiered system to lower damages where a nonpracticing entity (NPE) never licensed the patent and never made a good-faith attempt to license the patent. The reduction of damages would range from 25% if there is no attempt within one year after the patent was granted to 50% within three years following grant of the patent to 75% within five years following grant of the patent. This step, he says, serves as a major disincentive for NPEs to hold onto a patent and wait for infringement. The idea is to compel them to license so that the patent results in products being brought to market. Patents represent innovation, and rewarding innovation, at least in theory, is what the patent system aims for.

To read the complete paper, click here.

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Grabowski addresses cost of capital criticisms

A number of criticisms have been swirling around various issues relating to cost of capital. Roger Grabowski (Duff & Phelps) addresses these in a newly updated online education course that BVR is proud to offer.

On the hot seat: Models for developing cost of capital, such as the capital asset pricing model (CAPM), are being attacked as unreliable. Some say the size adjustment is no longer valid. Others argue that the specific company risk adjustment lacks a sound theoretical framework. Grabowski sorts through these issues during this unique online presentation.

This course, developed for the American Society of Appraisers, is designed around the landmark book, Cost of Capital, now in its fifth edition, co-authored by Grabowski and Shannon Pratt (Shannon Pratt Valuations). Topics covered in this course have been updated and expanded with the release of the new edition. They include the latest developments regarding data sources, the risk-free rate, the equity risk premium, beta and other measures of risk, alternative cost of equity capital models, issues with distressed companies, and pass-through entities.

For more information on Cost of Capital: An On-Demand Course, click here.

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Budding BVers compete in BVR/SPU Valuation Challenge

Promising young business valuators competed in the third annual BVR/SPU Valuation Challenge at Seattle Pacific University (SPU). This year, for the first time, university teams and faculty from across the U.S. competed in the challenge. Also, unlike other finance competitions, students valued a real U.S. private company using special appraisal information in a contest judged by 20 of the nation's senior valuation experts. The experts selected six teams from among 18 U.S. university first-round entrants to come to Seattle for the final round.

And the winner is: The competition was won by the University of Denver. Portland State University took second-place honors, and SPU was third. Middle Tennessee State University, University of Maryland (University College), and William Paterson University were the other participants.

BVR provided research support to the competing student teams. Moss Adams provided a full valuation report with only names and some locations changed. Three local experts—Willis Eayrs, deputy chairman of the International Association of Consultants, Valuators and Analysts (IACVA); Joseph Maas, principal of Synergetic Finance; and Miranda Rickert, senior analyst at Moss Adams—judged the competition's final round. William Hanlin, CEO of IACVA, participated as a consultant.

BVR congratulates all of the students who competed in this year’s Valuation Challenge and gives its thanks to Dr. Herbert Kierulff, SPU professor, who runs the event. For more information on the BVR/SPU Valuation Challenge, click here.

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First BV ‘Gold Seal of Trust’ issued

The International Society of Business Analysts (ISBA) has launched its exclusive "Business Valuation Gold Seal of Trust" award of excellence. ISBA started the Gold Seal program to provide clients with the assurance that business valuation firms are observing best practices.

Envelope, please: The first Gold Seal has been awarded to Habif, Arogeti & Wynne LLP (HA&W) for its business valuation services. According to HA&W, the firm was the subject of an exhaustive peer review of its people, processes, and work product as part of the ISBA program.

The Gold Seal program was developed by Howard Lewis, ISBA’s executive director, who designed the Internal Revenue Service’s business valuation training program as well as the Accredited in Business Appraisal Review credential issued by the National Association of Certified Valuation Analysts. Says Lewis: "Our goal and vision is to identify and recognize exemplary firms that have developed and maintain a high standard of integrity and excellence relating to core business values, management practices, processes, and excellence of operations and work product that are deserving of the public trust."

More information is available at the ISBA website.

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BV movers . . .

People: Darleen Armour joins BDO Consulting as a director in the Los Angeles office’s expanding Valuation Services practice … Robert J. Brown was named principal in the litigation and valuation services group of Cowan, Gunteski & Co., Tinton Falls, N.J. … Katherine Cordes joins the Colorado company Cordes & Co. as an associate director, with a primary focus on the firm’s recently enhanced business valuation services … Timothy Koch made partner in the Transaction Advisory Services practice in Cherry Bekaert LLP’s Charlotte, N.C., office … Kris Lowes joins investment banking firm Evans Senior Investments as a senior associate in its Chicago office … The Global Forensic and Dispute Services group of Alvarez & Marsal announced the addition of managing director John Brennan, a former senior detective at New Scotland Yard, and managing director Eric Stovall, a veteran expert witness and arbitrator focused on litigation and post-acquisition disputes.

Firms: Carr, Riggs & Ingram LLC acquired Auditwerx, a Tampa-based CPA firm that specialized in IT audit services, specifically SOC reporting … Grassi & Co. has been named one of the best companies to work for by the New York State Society for Human Resource Management and Best Companies Group … The regional accounting firm of Hartman Leito & Bolt LLC of Fort Worth announced it will combine forces with the national accounting and consulting firm BDO USA LLP effective June 1 … Valuation Research Corp. has appointed several officers to its board of directors: Ron Ewing, Ed Hamilton, and Charles Sapnas.

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Spring warms up with CPE events

The season is heating up with some very interesting CPE webinars.

Valuing Voting v. Non-Voting Stock (May 22), featuring Ronald Rudich (Gorfine, Schiller & Gardyn, Pa.). Discerning the value of voting and nonvoting stocks is much more than simple arithmetic. Learn what affects the values of these share types and how they affect the overall company value.

The Duff & Phelps Risk Premium Calculator: Utilizing New Data & Features for 2014 (May 29), featuring James Harrington (Duff & Phelps). This free webinar features a guided tour provided by the most knowledgeable expert on the Calculator: its co-creator, Harrington.

Contingent Consideration (June 3), featuring Travis Chamberlain (Clifton Gunderson) and Ron Elkounovitch (Ernst & Young). The Online Symposium on Fair Value Measurement turns to contingent considerations with a discussion on their measurement, interpretation, and the professional guidelines by which they are governed.

Valuing Government Contractors (June 5), featuring Donald Nalley Jr. (Beason & Nalley). With government contractors, many appraisers know more about the customer than about the vendor. Learn how these businesses operate and how their unique customer relationship affects their value.

Advanced Workshop on Monte Carlo Simulations: Applications & Examples (June 12), featuring David Dufendach, Randy Heng, and Oksana Westerbeke (all Grant Thornton). Confront your fears head on, and learn how to apply Monte Carlo simulations through two exhaustive case studies in this four-hour workshop.

Holiday break
After taking a break for Memorial Day, BVWire will be back on Wednesday, June 4. Have a happy and safe holiday!

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We welcome your feedback and comments. Contact the editor, Andy Dzamba at: or (503) 291-7963
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In this issue:

Fund valuation exams

Reasonable royalties

Cost of capital attacks

Fledgling BVers compete

First BV 'Gold Seal'

BV movers

CPE events




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